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Amidst Robinhood’s planned service changes, a tension between growth and safety

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Image Credits: Nigel Sussman (opens in a new window)

Robinhood’s growth as an ultra low-cost way to invest has shaken up fintech.

Fueled by hundreds of millions of external cash, the no-fee trading platform has forced domestic competitors to slash their fees, spawned international competition, and, in the eyes of some, helped propel the recent equities boom.

The company’s success in driving growth has led to surging revenues. As The Block recently reported, some Robinhood filings (here and here) show that the company earned “nearly $100 million in fees for stock and options order flow” in Q1 2020. For context, the same part of Robinhood’s business was reported to have generated $69 million in revenue during all of 2018.

For a startup valued north of $8 billion, Robinhood’s investors are betting that it will quickly scale as a business, something the famous unicorn appears to be doing in recent quarters and years.


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However, the same filings show that Robinhood’s incomes from payment for order flow — what Investopedia defines as “compensation and benefit a brokerage firm receives for directing orders to different parties for trade execution” — come more from options trading than they do the buying and selling of stocks in the manner that you might be more familiar with. (Robinhood makes money in a number of ways, including “income generated from cash,” its subscription service and other methods.)

Indeed, when TechCrunch first reviewed the filings that broke down how much income Robinhood earns from different types of order flow, we noted that the company generated comparatively large sums from options when contrasted to what the company could extract from more pedestrian equity orders. But the fact didn’t stand out too much at the time; the company has several trading varietals, so who cares which ones bring in more revenue?

It didn’t matter until the company’s user base recorded a tragedy after a 20-year-old user died by suicide after the Robinhood app showed them a balance to the tune of negative $730,000. It turns out the balance wasn’t really a debt, but apparently a midtrade options UI quirk.

The episode lit up the media, snagging coverage in publications far and wide.

Changes

To its credit, Robinhood didn’t shy away from the issue, instead talking publicly about what happened and what it was going to change to prevent something similar from happening again.

The firm detailed a few upgrades to its service, which we’ll quote here:

  1. Eligibility: We are considering additional criteria and education for customers seeking level 3 options authorization to help ensure customers understand more sophisticated options trading.

  2. Educational resources: We are expanding our educational content related to options trading. We have added information on early options assignments to our help center and we will be hiring an Options Education Specialist to further enhance education related to our options offering.

  3. User Interface: In the near term, we are rolling out improvements to in-app messages and emails we send customers about their multi-leg options spreads. We are also adding detail to the in-app history page to help users understand the mechanics of early options assignments. We are also working on changes to our user interface, including the way buying power is displayed. These changes will take a bit of time to roll out, but our teams are hard at work.

The latter two efforts are common sense, and obvious in a clear and good way; do them, in other words.

The first proposed changed is trickier. If Robinhood makes it more difficult to access options trading, fewer users may utilize it. That could limit the company’s ability to grow an important revenue stream, putting user safety in something close to opposition with business growth.

The company declined to comment on the balance in an email exchange with TechCrunch.

Revenues

Robinhood is not the only provider of low-cost options trading; OptionsAI is in the space, as is Webull. We might even anticipate more competitors in the future given how lucrative selling options trading order flow can be.

Let’s look at the data. You can see how much Robinhood earned from payment for options order flow in March 2020 here:

Image Credits: Robinhood via SEC filing

Contrast the numbers to, say, payment for S&P 500 stock order flow from the same month:

Image Credits: Robinhood via SEC filing

There’s a business advantage in allowing users to trade options as opposed to merely facilitating the buying and selling of regular shares, as there’s lots of money to be made in them for firms that execute the trades. It will be fascinating to see how Robinhood balances its need to grow revenue to meet investor expectations and keep customers safe.

When it comes to younger, quickly growing companies, I’m inclined to let them make mistakes and fix things before getting too vexed. So, I’m not here to excoriate Robinhood so long as the company follows through with its pledge to make its platform safer, especially for younger, less sophisticated traders.

If it doesn’t do a good job of that, we’ll have ample reason to criticize the firm.

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